### IN THE UNITED STATES COURT OF APPEALS FOR THE FIFTH CIRCUIT

No. 13

- 10601

GORDON POTTS; BRANDY WEST , Plaintiffs

– Appellants,

v. CHESAPEAKE EXPLORATION, L.L.C. , Defendant

– Appellee.

Appeal from the United States District Court for the Northern District of Texas

Before JONES , SMITH , and OWEN, Circuit Judges

. PRISCILLA R. OWEN, Circuit Judge : The meaning of royalty provisions in an oil and gas lease are in dispute. Gordon Pot ts and Brandy West (the lessors ) appeal the district court’s grant of summary judgment in favor of the lessee, Chesapeake Exploration, L.L.C. (Chesapeake)

. W e affirm.
I Potts and West are two of the lessors in an oil, gas, and mineral lease i n which Chesapeake is the successor

- lessee to FSOC Gas Co. , Ltd. (FSOC)

. Three paragraphs of the lease are at issue . Paragraph 11 provides in relevant part: The royalties to be paid by Lessee are: . . . on gas . . . the market value at the point of sale o f 1/4 of the gas sold or used

. . . . Notwithstanding anything to the contrary herein contained, all United States Court of Appeals Fifth Circuit 

### FILED July 29, 2014 Lyle W. Cayce Clerk Case: 13-10601 Document: 00512714817 Page: 1 Date Filed: 07/29/2014No. 13

- 10601 royalty paid to Lessor shall be free of all costs and expenses related to the exploration, production and marketing of oil and ga s production from the lease in cl uding, but not limited to, costs of compression, dehydration, treatment and transportation. Paragraph 29 contains a “favored nation” provision , which states: Lessee agrees if Lessee or any of its Working Interest Partners has agreed to pay or lat er agrees to pay a higher royalty or bonus consideration to another landowner, mineral owner or other parties, (in the same drilling unit, spacing unit or pooled or utilized land to which the leased land s are included), then Lessee shall pay to Lessor an a mount based on such higher royalty, or bonus consideration retroactive to the effective date of the Lease(s). P aragraph 37 provides , in pertinent part : Payments of royalties to Lessor shall be made monthly and shall be based on sales of leased substances t o unrelated third parties at prices arrived at through arms length negotiations. Royalties to Lessor or leased substances not sold in an arms length transaction shall be determined based on prevailing values at the time in the

area. Lessee shall have the obligation to disclose to Lessor any information pertinent to this determination. An affiliate of Chesapeake, Chesapeake Operating , Inc. (COI) , operates the lease on Chesapeake’ s behalf. COI , as agent for Chesapeake, sells gas produced from the lease to Chesapeake Energy Marketing, Inc. (CEMI), another affiliate of Chesapeake, at the well head located on the lessors’ property. CEMI then transports the gas through a gathering system and

re sells it to unaffiliated purchasers at gas pipeline hubs that are considerable
distances from the wellhead

. The sales to unaffiliated purchasers occur at delivery points that include the Houston Ship Channel and locations in Louisiana and Alabama. CEMI pays Chesapeake the weighted average sales price that CEMI receive s when it sells the gas downstream, after deducting post

- production costs that CEMI incurs between the wellhead and the points at which deliveries to unaffiliated purchase r s occur

. The royalty that Chesapeake pays to the lessors is 1/4 of the price it receives from CEMI.

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- 10601
Potts protest ed to Chesapeake that his royalty payments were improperly calculat ed because post

- production costs had been deducted in arriving at the value on whi ch royalty was based . Potts also questioned whether Chesapeake had complied with the favored nation clause and
demand ed access to Chesapeake’s records. Chesapeake initial ly agreed that i t should not have deducted post

- production costs in calculating roya lties and paid Potts accordingly

. However, Chesapeake subsequently changed its position, asserting that its original concession regarding post

- production costs was a mistake. Chesapeake conceded that it had failed to pay Potts the amount
he was due under the favored nation provision , but in tender ing what was owed under that provision of the lease , Chesapeake withheld the amount it
contended was an “ over
- payment” of royalties due to post

- production costs that Chesapeake had no t, but was entitled to, deduc t

. Potts filed suit against Chesapeake in Texas state court, alleging breach of contract and seeking a declaratory judgment that Chesapeake was not permitted to deduct post

- production cost s in calculating royalty . After Chesapeake removed the case to federal district court on the basis of diversity jurisdiction, West joined the litigation as a plaintiff. West claimed that Chesapeake initially paid her royalties without deductions for post

- production
costs , but then ceas ed remitting paymen ts altogether on the ground that she had been overpaid and Chesapeake was recoup ing the difference out of future payments

. The parties filed cross

- motions for summary judgment. The district court granted Chesapeake’s motion and denied that of the lesso rs. Construing the lease under Texas law, the court held that Chesapeake was permitted to calculate “market value at the point of sale” by starting with the market value received from unaffiliated purchases and subtracting reasonable post

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- 10601 production costs incurred between the downstream points of sale to unaffiliated purchasers and the point of sale to CEMI

. The lessors moved for reconsideration, arguing inter alia that because royalty payment s are to be calculated based on sales to unrelated third partie s under paragraph 37 of the lease, the “point of sale ” to be considered is the point
at which CEMI sold the gas to unaffiliated purchasers

. The district court
denied the motion

. The lessors timely appealed.
II “We review a district court’s grant of summary judgment de novo, applying the same standard as the district court.” 1 Under that standard, “[s]ummary judgment is proper ‘if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a
matt er of law.’” 2 “We generally review a decision on a motion to alter or amend judgment under [Federal Rule of Civil Procedure] 59(e) for abuse of discretion. To the extent that a ruling was a reconsideration of a question of law, however, the standard of r eview is de novo .” 3
III The parties agree that Texas law applies in construing the lease

. 4 Under Texas law, “[a]n oil and gas lease is a contract, and its terms are interpreted as such.” 5 The parties further agree that the lease in this case is unambig uous. “In construing an unambiguous oil and gas lease our task is to ascertain the

1 10 Ring Precision, Inc. v. Jones , 722 F.3d 711, 717 (5th Cir. 2013) (citation omitted).

2 Id. (quoting F ED

. R. C IV

. P . 56(a)).

3 Miller v. BAC Home Loans Servicing, L.P. , 726 F.3d 717, 721

- 22 (5th Cir. 2013) ( citations and internal quotation marks omitted).

4 See Clardy Mfg. Co. v. Marine Midland Bus. Loans Inc. , 88 F.3d 347, 352 (5th Cir. 1996) (“We look to state law to provide the rules of contract interpretation.”)

.
5 Tittizer v. Union Gas Corp. , 171 S.W.3d 857, 860 (Tex. 2005) (per curiam). 4 Case: 13-10601 Document: 00512714817 Page: 4 Date Filed: 07/29/2014No. 13

- 10601 parties’ intentions as expressed in the lease.” 6 We are to “examine the entire document and consider each part with every other part so that the effect and meaning of one part on any other part may be determined.” 7 Additionally, “[w]e give terms their plain, ordinary, and generally accepted meaning unless the instrument shows that the parties used them in a technical or different sense.” 8 A We begin our analysis of the l ease’s provisions with the royalty clause in paragraph 11. It provides that royalties on gas are “the market value at the point of sale of 1/4 of the gas sold or used.” This unambiguously requires Chesapeake to pay 1/4 of the market value of the gas at t he point at which Chesapeake sells the gas. If, as in the present case, the lessee sells the gas at the wellhead, there generally will be no post

- production costs incurred by the lessee. If the lessee sells the gas downstream from the wellhead, then the lessee would be required to pay 1/4 of the market value of the gas calculated at that point of sale and c ould not deduct post

- production costs incurred between the wellhead and the point of sale.
The lessors contend that there are other provisions in the lease that modify or override this part of the royalty clause. They rely on the following language, also found in the royalty clause in paragraph 11 of the lease: Notwithstanding anything to the contrary herein conta ined, all royalty paid to Lessor shall be free of all costs and expenses related to the exploration, production and marketing of oil and gas production from the lease including, but not limited to, costs of compression, dehydration, treatment and transport ation.

6 Heritage Res., Inc. v. NationsBank , 939 S.W.2d 118, 121 (Tex. 1996 ).

7 Id

.
8 Id. 5 Case: 13-10601 Document: 00512714817 Page: 5 Date Filed: 07/29/2014No. 13

- 10601
T he above

- quoted language directs that “royalty” is to be “free of all costs and expenses related to the exploration, production and marketing of” gas “including, but not limited to, costs of compression, dehydration, treatment and transportation.” As discussed above, when gas is sold at the wellhead, there are typically no costs of compression, dehydration, treatment or transportation. When there are no such costs at the wellhead, the market value at the wellhead is “free of all costs and expenses ,” as contemplated by
the above

- quoted paragraph, and there is nothing in the royalty clause “contrary” to the “[n]otwithstanding” sentence. If the gas is sold by the lessee downstream of the wellhead, then both the sentence provid ing for a 1/4 royalty

an d the “[n] otwithstanding” sentence contemplate that costs incurred by the lessee between the point of production and the point of sale are to be borne by the lessee. Since it is undisputed that gas sales by Chesapeake have occurred at the wellhead, and si nce the lessors do not contend that the sales to unaffiliated purchasers were at less than market value, Chesapeake could arrive at the market value at the wellhead by deducting reasonable post

production costs to deliver the gas from the wellhead to the p oint at which the gas was sold to unaffiliated purchasers. The district court correctly concluded that Chesapeake’s calculation of royalties is consistent with the methodology for calculating market value at the wellhead explained by the Supreme Court of T exas in Heritage Resources,
Inc. v. NationsBank

. 9 In Heritage , the royalties to be paid under the leases

were a percentage of the gas’s “market value at the well.” 10 The leases further provided that “there shall be no deductions from the value of [the] Le ssor’s royalty by reason of any required processing, cost of dehydration, compression,

9 939 S.W.2d 118 (Tex. 1996).

10 Heritage , 939 S.W.2d at 120

- 21. 6 Case: 13-10601 Document: 00512714817 Page: 6 Date Filed: 07/29/2014No. 13

- 10601 transportation , or other matter to market such gas.” 11 The Supreme Court of
Texas held that the lessee had not breached the lease in arriving at market value of gas at t he wellhead by deducting post

- production transportation costs from the market value ascertainable at a downstream point

. 12 The court explained, “ [t] here are two methods to determine market value at the well. ” 13 “The most desirable me thod is to use comparab le sales ” at the well. 14 When information about such sales is not readily available, the market value at the
well is determined by taking the market value of the gas at a point downstream where sufficient information is available, and then “subtracting rea sonable post

- production marketing costs,” such as transport ation and processing

expenses. 15 The “no deductions” clause, the court continued, simply “ restate [ d ] existing law ” by providing that the lessors’ royalty, which could be calculated using the two methods described , may not be further reduced because o f

costs. 16 The lessors insist that that the “[n]otwithstanding ” senten ce is distinguishable from the “ no deductions ” clauses at issue in Heritage and should be given a different meaning. The clauses in Heritage stated that “there shall be no deductions from the value of [the] Lessor’s royalty by reason of any required processing, cost of dehydration, compression, transportation , or other matter to market such gas.” 17

11 Id.

12 Id. at 123

- 24

.
13 Id. at 122.

14 Id.

15 Id.

16 Id.

17 Id. at 120

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- 10601 The lessors contend that, unlike t he clauses at issue in Heritage , a sentence in their lease provides that all royalties shall be free of all costs. The lessors argue that the lease does not simply prohibit deductions from a given value, but provides affirmatively that the royalty may not be “burdened” with any costs. They maintain that subtracting post

- production costs from sales that occur miles from the wellhead to derive the market value at the point of sale, in this case the wellhead, burdens the royalty with such costs. This argume nt misunderstands Heritage and is mathematically
unsound. The Heritage court held that the “no deductions” clauses were not in conflict with the roy alty provisions. The deduction of post

- production costs incurred between the wellhead and a downstream po int at which market value could be ascertained was nothing more than a method of determining market value at the well in the absence of comparable sales data at or near the
wellhead. The value of the gas, and therefore the value of the royalty , was not reduced. As the concurring opinion stated, “[t]he concept of ‘deductions’ of marketing costs from the value of the gas is meaningless when gas is valued at the well. Value at the well is already net of reasonable marketing costs.” 18 That reason ing is equally applicable to the clause at issue in this case. The value of the lessors’ royalty is a percentage of the market value at the point of sale, which in this case is at the well. A “net

- back” method of calculation does not “burden” or reduce t he value of the royalty

. 19
B The lessors contend, however, that the lease prohibits the point of sale from be ing at the wellhead if Chesapeake sells the gas to an affiliated entity.

18 Id. at 130 (Owen, J., concurring).

19 See also Warre n v. Chesapeake Exploration, L.L.C. , No.13

- 10619, 2014 WL 3511880 , at *3 (5 th Cir. 2014). 8 Case: 13-10601 Document: 00512714817 Page: 8 Date Filed: 07/29/2014No. 13

- 10601 The lessors rely on paragraph 37 of the lease , which r equires that royalt y payments be “based on sales . . . to unrelated third parties at prices arrived at through arm s length negotiations.” Chesapeake argues that the lessors waived their reliance on paragraph 37 by failing to raise the issue in the district court until the l essors’ motion for
reconsideration. Even if the lessors preserved their relian ce on paragraph 37 , a question that we do not reach, it does not support their position

. Paragraph
37 says, in pertinent part: Payments of royalties to Lessor shall be made mon thly and shall be based on sales of leased substances to unrelated third parties at prices arrived at through arms length negotiations. Royalties to Lessor or leased substances not sold in an arms length transaction shall be determined based on prevailing values at the time in the area. Lessee shall have the obligation to disclose to Lessor any information pertinent to this determination.
This section of the lease specifically contemplates that if the lessee sells the gas to an affiliate, t he royalty shall “be determined based on prevailing
values at the time in the area .” Paragraph 37 does not require the point of sale to be the point at which the gas is ultimately sold to a non

- affiliated entity. The lessors argue that construing “point of sale” as the point where Chesapeake sells the gas to CEMI would frustrate the parties’ expectations
and their reliance on the concurring opinion in Heritage

. They rely on the following passage from the concurring opinion: There are any number of ways the parties could have provided tha t the lessee was to bear all costs of marketing the gas. If they had intended that the royalty owners would receive royalty based on the market value at the point of delivery or sale , they could have said so. 20

20 Heritage , 939 S.W.2d at 131 (Owen, J., concurring) (emphasis in original)

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- 10601
The concurring opinion emphasized that the parties to a lease “may allocate costs . . . as they choose” and that court s must examine the specific language
chosen in order to “determine how

. . . costs were allocated under [the] particular leases” at issue. 21 In this case, the l anguage of the lease , including paragraph 37, make clear that the royalty due the lessors is a percentage of
the market value of the gas at the point at which the lessee sells the gas

. As discussed above, had Chesapeake sold the gas at a point downstream from the wellhead, then the royalty would be 1/4 of the market value of the gas at that point. Post

- production cost incurred between the wellhead and the point of sale could not be deducted in arriving at the market value at the point of sale
under either the “1/4” royalty sentence in the royalty clause of paragraph 11, or any other provision in the lease. But Chesapeake has sold the gas at the wellhead. That is the point of sale at which market value must be calculated under the terms of the lessors’ le ase. C
T he lessors contend that the district court erred by relying on Heritage
, asserting that the case has limited precedential value. They note that after the opinion in Heritage issued, one of the Justices who had joined the majority opinion recused himself . T he other members of the Supreme Court of Texas split 4

- 4 in ruling on a motion for rehear ing

. An opinion dissenting from the denial of rehearing reflects that two of the Justices who had originally joined the majority opinion had changed posit ion and had expressed their agreement
with the original dissenting opinion. 22 The lessors argue that the Texas court

21 Id. at 124.

22 See Heritage Res., Inc. v. NationsBank , 960 S.W.2d 619, 619 (Tex. 1997). 10 Case: 13-10601 Document: 00512714817 Page: 10 Date Filed: 07/29/2014No. 13

- 10601

was thus without a majority that agree d on the reasons supporting the judgment in Heritage

. Because rehearing was denied, the court’s opi nion in Heritage was not withdrawn. The Texas court’s decision in Heritage remains binding law, as the numerous cases from both the S upreme Court of Texas and this court citing
that decision demonstrate

. 23 * * * For the foregoing reasons, the judgment of the district court is
AFFIRMED

.

23 See, e.g. , Ramming v. Natural Gas Pipeline Co. of Am. , 390 F.3d 366, 372 (5th Cir. 2004); El Paso Field Servs., L.P. v. Mastec N. Am., Inc. , 389 S.W.3d 802, 808 (Tex. 2012); Union Pac. Res. Grp., Inc. v. Han kins , 111 S.W.3d 69, 71 (Tex. 2003). 11 Case: 13-10601 Document: 00512714817 Page: 11 Date Filed: 07/29/2014